SelfInformed

April 2015


Common Lending Options for Small Businesses

Thursday, April 23, 2015

When you run a small business, sometimes you won’t have enough cash to cover all your needs. You might want to fund an expansion, stock up on inventory, or just get some extra money to cover your expenses during a slow stretch. To help with these expenses, you could take out a business loan.

There are a number of different lending options available for small business owners and each its own strengths and weakness. To help you find the best choice, here is a review of the top lending options for entrepreneurs and small business owners.

Bank loans

When you need a loan, the bank might seem like the most obvious place to go. A bank loan can be convenient to manage especially if you take out a loan from the bank managing your business accounts. Bank loans also charge a relatively low interest rate. For example, the average small business loan for $9,000 or less charged an interest rate of 7% a year. Banks charge less for larger loans as you can see below.

However, for many new business owners, bank loans aren’t an option. Since the financial crisis, banks have tightened up their lending standards so it’s hard for brand-new businesses to qualify. You most likely need to have been in business a few years to build up the income history and credit score to qualify.

If you’re starting a business and want a bank loan, you can improve your chances of qualifying by personally guaranteeing the loan. This can be risky though because if your business fails, the bank can go after your personal assets for payment like your house or your savings.

SBA loans

The Small Business Association is a government organization designed to help small business owners in the United States. They have a few different programs to help provide financing to small businesses. The SBA doesn’t actually lend money. Instead, they guarantee your bank loan. This helps if you weren’t able to qualify for a regular bank loan.

In exchange, SBA loans charge a higher interest rate than regular bank loans. The SBA charges an extra fee as insurance to make up for the fact that people borrowing through their program couldn’t qualify for regular bank loans. As a result, you should see whether you can qualify for a bank loan first before considering an SBA loan.

Credit cards

If you fund your family business through your credit cards, you wouldn’t be the first. According to the Federal Reserve, 80% of small business owners use credit cards for financing while 60% of businesses depended on credit cards to survive their first year of business.

The advantage of using your credit card is that it’s convenient. You can immediately start using your personal credit cards or apply for a business credit card. Using a business credit card and paying the bills on-time every month will help build your business credit score, which will help your business qualify for other types of loans in the future.

The downside of using credit cards is that they charge a high interest rate. If you don’t pay off your purchases every month, the interest rate on a credit card will be about 15%, about double what you’d pay on a bank loan.

One way to keep your costs down is to look for a new card with a 0% introductory APR. These cards don’t charge interest on your account balance for a set amount of time, usually a year or more. This saves you money while you’re building a business and then you can pay off your balances when you’re in better financial shape.

Friends and family

Your friends and family want you to succeed and may be able to contribute to your business. If you’re going to borrow money from a friend or family member, it’s important to keep the arrangement as formal as possible. This shows that you’re serious about growing a business and are committed to paying the money back.

When you meet with people, you should have a formal business plan ready that explains how you’ll run your company, your current situation, and your expected sales growth and profits. If someone gives you a loan, you should set up a formal loan agreement that clearly states how much you owe, when you’ll make payments and the interest rate on your loan.

The advantage of working with friends and family is that you can get a loan without the same formal requirements as working with a bank or the SBA. The downside is you have to be very careful to responsibly manage the loan so you don’t damage your personal relationships.

Peer-to-peer lending

The internet has opened up new ways for businesses to find financing. One of these new systems is peer-to-peer lending. On a P2P lending website like Prosper or Lending Club, you put together a profile for your business explaining who you are, what your business does, and how much money you’d like to borrow.

Individuals open accounts on these websites to lend money to business owners as an investment. If people like the sound of your company, they’ll give you small loans to help you fund your operations.

P2P loans can be set up more quickly than bank loans since you’re dealing with individuals who have fewer requirements. It also means you might be able to qualify for one of these loans even if you couldn’t qualify for a bank loan. The downside is you have less control over your loan interest rate and you could get stuck accepting a rate that’s significantly worse than a bank. It’s also possible that you won’t get any loan offers so the time you spend setting up your account would be wasted.

Asset-based loans

If your business owns any valuable assets, you can use these assets to secure an asset-based loan. This is when you put up your assets as collateral for your loan. You can use property like valuable equipment, buildings, real estate, etc. The lender will appraise the value of your assets and lend you money based on that value.

Asset-based loans are easier to qualify for than bank loans since you’re putting up collateral. Some lenders might also charge a lower interest rate because of this collateral. The downside of this type of loan is that if you can’t make your payments, the lender can eventually seize your valuable asset. Also, an asset-based loan isn’t an option if your business doesn’t own any valuable assets yet.

Merchant cash advances

If your business accepts credit cards for payment, you can also borrow money through a merchant cash advance. With a merchant cash advance, the lender looks at how much money you’re taking in per month with credit card sales and will tell you how much money they’ll advance you based on that. When you qualify, you’ll receive an upfront, lump-sum payment.

Going forward, you’ll need to pay a percentage of your credit card sales for a set period of time. For example, you might need to pay 10% of your credit card sales for a year to pay back the advance.

The key benefit of a merchant cash advance is that they’re quick and easy to set up. As long as you have a few months of credit card sales, you’ll likely qualify and will receive your money within a week. The downside is that these loans are extremely expensive. The APR of a merchant cash advance can be as high as 60% to 200% so you need to use these loans sparingly.

At NASE, we understand that you can’t build a business all on your own and you don’t have to. By taking advantage of one of these lending options, your company will have the money it needs to grow and succeed.

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